Portugal's Constitutional Court ruled Friday that a fifth of the government's planned budget cuts were unconstitutional, in part because they were discriminatory and retroactive.

Francisco Seco/AP

Portugal's Prime Minister Pedro Passos Coelho (c.) gestures during a debate in the Portuguese parliament in Lisbon on Friday. Portugal's Constitutional Court ruled on Friday that some of the unpopular pay cuts in this year's state budget are unlawful, threatening the country's economic recovery.

In another serious challenge to Europe’s economic recovery, the Portuguese government said late Sunday that it will further cut spending in education, healthcare, social security, and state companies to offset austerity measures that the highest court ruled unconstitutional late on Friday.

The Constitutional Court overturned salary and pension cuts targeting public employees that are equal to around 20 percent of the more than 5 billion euros ($6.5 billion) approved as part of the 2013 budget. The court ruled that the measures were discriminatory in part because they only affected part of the labor force, and were retroactive to Jan. 1, 2013.

Inevitably, Mr. Passos Coelho said, social services will have to be cut “to compensate” for the court-mandated revisions to the 2013 budget. He didn’t say what specifically would be trimmed.

While the court decision and resulting budget cuts present political risks in the middle and long term, its effects are more immediately economic. Portugal may now need a second extension of its 2013 deficit target to be able to reach it, and may even require a second bailout – potentially upending the country's economic progress and delaying the European recovery.

Either way, the economic scrambling will undermine the country’s efforts to once again gain access to credit markets.

A new deal with the troika?

Passos Coelho harshly criticized the court ruling and said it will compound the pain Portugal is already feeling from public cuts of more than 13 billion euros ($17 billion) in the last two years.

The ruling also comes only days before Portugal asks its troika creditors for more flexible terms in talks planned for this weekend. In March, it received a two-year extension, until 2015, to the 78 billion euro bailout package ($101 billion) negotiated in 2011 to meet the European deficit target of 3 percent of the gross domestic product.

The new 2013 target agreed to in March was 5.5 percent, from 6.4 percent in 2012, but the court ruling could derail that. Portugal will face “serious difficulty” to meet its international financial commitments and its budget targets, the government said after a Sunday cabinet meeting in response to the ruling.

The troika has suggested it is open to talks with Portugal, despite persistent delays to the country meeting its goals, no doubt to avoid opening yet another flank in the troika's ongoing efforts to control the economic crisis. But depending on the political and economic evolution, Portugal could be forced to ask for more money.

“We need to do everything to avoid a second bailout,” said Passos Coelho. But that will depend on his troika creditors and also how markets react to yet another obstacle to the country’s economic recovery.

Despite controversially threatening to resign if the court found the budget unconstitutional, it remains unlikely that Passos Coelho will do so imminently. His party holds a comfortable majority in parliament and enjoys strong institutional support after surviving several no-confidence votes, including one last week.